INVESTMENT PROCESS

INTERNALLY DRIVEN RESEARCH EFFORT

We focus on investing in companies outside the S&P/ASX 100 Index believing smaller Australian companies to be:

  • easier to understand
  • simpler to value, and
  • more accessible to research.

Our belief is that the opportunities for significant growth of well-positioned, well-managed and well-resourced smaller companies is often greater than that of larger businesses.

Access to key management and earnings transparency is also critical.

We visit over 1000 companies a year

To understand the drivers of a business, we visit companies and talk to management regularly. We believe this gives us an analytical advantage.

Disciplined and repeatable process

The stocks we include in our Premium Small Companies portfolio, for example, we analyse using a four-stage process:

Disclaimer
Number of securities are for illustrative purposes only. Actual numbers may vary.

“Our proprietary investment process has yielded strong long-term returns for our investors.”

Stephen Evans
Senior Investment Analyst

1. Initial screen

During this stage, we aim to screen out businesses with:

  • no profitability or cash flow
  • a market capitalisation of less than $50 million (due to liquidity and quality consideration)
  • complex technologies which are difficult to forecast
  • unproven business model
  • insufficient diversification of product or supply (e.g. single commodity/single mine), or
  • management that is not aligned with its shareholder or that is inaccessible.

In limited circumstances, we may hold stocks that have migrated into the S&P/ASX 100 Index (up to 20% of the portfolio). If we had covered the stocks closely as smaller companies and their business model hasn’t materially changed and we retain good access to senior management, we may still hold the stock as long as it remains a compelling investment proposition.

2. Operational risk assessment

We then rank stocks based on our operational risk which focuses on:

  • management
  • business model
  • operating history
  • industry structure
  • corporate structure, and
  • financial analysis.

If a stock fails to meet our investment grade threshold level, we screen it out as being too risky.

3. Valuation screen

During this stage, we assess and rank stocks’ expected total returns (capital appreciation plus dividend). We then build our own bottom-up stock models with heavy focus on accurately forecasting the key drivers of the profit and loss statement. OC‘s preferred valuation techniques include:

  •  EV/EBITDA and PE ratios
  • sum-of-the-parts valuation, and
  • discounted cash flows, where long term cash flows can be forecast with sufficient certainty.

4. Potential portfolio holdings

In constructing the portfolio, we assess our current stocks and potential inclusions and apply any required thematic overlays. We use a proprietary matrix to asses a company’s operational risk versus its expected return to derive an appropriate weighting for a stock in the portfolio.

We give additional consideration to constraints, such as S&P/ASX 100 index exposure limits, liquidity and correlation or diversification considerations. As the process typicaly yields more investment opportunities than would fit in the portfolio, these overlays help us trim the set of opportunities to provide the highest quality diversified portfolio.

We hold stocks with better risk/return charactertistics at higher weights in the portfolio.

We have a strong sell discipline

“Our sell discipline is critical to our investment process which we believe can be poorly executed by many investors.”

Stephen Evans
Senior Investment Analyst

The main reasons we sell a stock include:

  • it reaches our valuation target
  • the investment thesis changes or our key assumptions are proven wrong
  • the stock’s financial or operational expectations are not met
  • we are misled or lose confidence in management, or
  • we believe there is a better use of capital.

We also think about the tax consequences before selling a stock, but it is not our primary consideration.

Managing risk

Risk Management Committee

Our Risk Management Committee provides a top-down overlay to complement our bottom-up stock selection process. In addition, our proprietary database generates specific risk management reports such as portfolio sector exposures and performance attribution.

Broadly, the committee assists with:

  • Sector and stock weightings
  • Liquidity issues
  • Portfolio attribution analysis and specific risk
  • Macro thematics and systematic risks
  • Public Policy issues
  • Global factors impacting or likely to influence markets
  • Other issues impacting markets

Environmental, social and governance considerations

We explicitly embed ESG issues in the operational risk assessments we undertake on all potential investments and consider ESG principles in our stock valuation process.

  • Key considerations include:
    • Whether management acts ethically and in the best interests of shareholders
    • Transparency of a company’s ESG measures
    • Longevity of the industry structure in which the company operates (environmentally, socially and economically)
    • Corporate governance track record of the company